In a recent post I mentioned that business owners may – among other benefits of entrepreneurship – achieve some tax savings. This week, inspired by my words, you’ve decided to hang a shingle.
However, you need money. But where can you get money for a small business?
Let me tell you all the great ways.
Inherit the money
I can’t recommend this highly enough. Your first $5.45 million of inherited money comes to you tax-free! Up from $5.43 million way back in 2015! And you don’t even have to work for it! Let’s make this happen, people!
Sadly, you need to be born into the right family, which is tricky to make happen on purpose. Also sadly, a beloved family member has to die at the right time. This is impractical for most of us. Let’s review the other great ways.
A bank loan
Naturally, you could simply walk into your bank and tell them about your great skills, customers, and market plan. Your friendly banker pulls your credit report and quickly understands your business plan. You’ll walk out with the money you need to grow and expand your small business. It’s so cool. This is the best way to get money for your small business.
Ha-ha. Just kidding. This is the worst way, because banks don’t actually lend money to new small businesses.
When you try this (Actually I don’t recommend trying this, but feel free to knock yourself out) your friendly banker will ask for two years of financial records and business tax returns. Then you try to tell him about your great skills, customers, and market. He will stubbornly return to your lack of two years’ financial records. Eventually you realize this is a dead end.
A friend or family loan
Let’s pretend your friend or family member (hereafter known as “framily”) has money, understands you, and wants to help. Your framily1 doesn’t need to pull credit or make you wait for two years worth of business financials. Your framily lends you just the right amount of money, and she only asks for an affordable interest rate in return. Maybe best of all, when your small business succeeds wildly, by taking a loan you keep all the business ownership to yourself, so you can get rich without having to share that wealth with your framily. This is the very best sort of money for your small business.
No, wait, it’s totally not.
First of all, your small business faces very uncertain prospects in its first few years, at best a ‘feast or famine’ type of profitability. A fixed rate loan, with the obligation to make regular payments – every single month – invites disaster. Many months, especially in the beginning, you might find it impossible to pay your loan.
Which of course leads to the second issue of borrowing from your framily. Defaulting, or even asking to restructure a loan from framily will put grave stress on your closest relationships. In sum, never get a business loan from a friend or family member.
Equity investment
Well now, wait a minute, clearly the best way to raise money for your new small business is to approach your framily, and instead of getting a loan, you get a direct equity investment. You sell part ownership in your business. Your framily believes in you and is flexible and, unlike in the case of a loan – which requires fixed monthly and possibly unaffordable payments – you only need to share profits (eventually!) with your new co-owner(s). Clearly this is the very best way to raise money for your small business.
No, sorry, this is a terrible idea. Been there, done that.
In the best case, you’ve given up too much of your future profits to someone else.
In the more probable worst case (Remember, most small businesses fail in the first few years!) you have now lost the money of your closest relationships, in addition to losing your hopes, dreams, and income source.
In my own case, I lost the money of my best friend, mother, and eight-grade English teacher, among others. This isn’t fun. Be sure to budget in money for therapy, which isn’t cheap, either.
How about instead of friends and family, you raise equity from professional angel investors or venture capitalists? This may remove the therapy part of the equation if you fail, because we may feel less remorse after losing the money of professional investors. On the other hand, the professional investors will likely negotiate a better deal for themselves than would your framily. They are the shark at the poker table and you are the fish. So if you do well with your small business you’ve probably given up too much of your future profits.
Crowd-sourcing
I have not yet mentioned new-fangled techniques for raising money, such as crowd-sourcing.
Call me old school, but I have yet to hear of a legitimate for-profit business that effectively crowd-sourced money. I believe in crowd-sourcing as a great marketing tactic, and possibly great for non-profit or charitable projects as a result, but I don’t think it works for most small businesses.
My point
What’s my point in raising and then rejecting all of the available small-business financing options?
Simply this. It’s really, really hard to raise money for a small business. If you know a successful small business owner, give her a hug. She deserves it.
In an upcoming post – just so I don’t leave you bereft of hope – I’ll mention a few small business financing alternatives that you could try.
Please see related posts:
Entrepreneurship – Getting Started is the Hardest Part
Entrepreneurs: Pack Half The Luggage, Bring Twice The Money
Entrepreneurship And Its Discontents
Entrepreneurship Part I – Equity v Fixed Income
Entrepreneurship Part II – Lessons From Finance
Entrepreneurship Part III – The Air, The Taxes, The Retirement
Death (Estate) Taxes and Fairness
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- After I wrote this I Googled ‘framily’ and found it’s a phrase used by Verizon to pitch their phone plans. Ugh. Really didn’t mean to be promoting them. ↩
